Tax on bonds trips people up because two completely different taxes are involved, one on the interest and one on any gain from selling, and they get conflated constantly. Keep them separate and the picture is manageable.
This is general information, not tax advice. Rules for debt instruments have changed repeatedly in recent years. Confirm the current position for your assessment year with a qualified adviser before acting on any figure.
Tax on interest
Interest from a corporate bond or NCD is taxed as Income from Other Sources, added to your total income, and taxed at your slab rate. There is no special rate, no concessional treatment, and no indexation for interest.
The effect is large. For someone in the 30% bracket, with cess the effective rate on interest is about 31.2%. An 11% coupon is worth roughly 7.6% after tax. Any comparison of a bond against another slab-taxed instrument, a fixed deposit for example, has to be done post-tax to mean anything. The NCD returns calculator and the FD vs bond calculator both apply the slab so you can see the real figure.
Interest is taxable as it accrues or is received, whichever method you follow. This matters for cumulative NCDs, which accumulate interest and pay it all at maturity. The tax on that interest is still due year by year as it accrues, so the tax bill arrives before the cash does. A cumulative NCD's large maturity value is not a tax-deferred return.
TDS on interest
The exemption that previously applied to interest on listed securities held in dematerialised form was withdrawn with effect from FY 2023-24. TDS now applies to interest on listed NCDs above the applicable threshold, at the prescribed rate. TDS is an advance against your liability, not the final tax. If you are in a higher slab you still owe the balance, and if your income is below the taxable limit you can prevent deduction with Form 15G or 15H, or claim it back on filing. TDS on NCD interest covers the mechanics.
Tax on selling before maturity
Sell a bond before it matures, and the difference between your sale price and your cost is a capital gain or loss, taxed under its own rules rather than as interest.
The holding period determines whether the gain is short-term or long-term. For listed bonds and NCDs, the threshold is 12 months. Sell after holding longer than a year and the gain is long-term. Sell sooner and it is short-term. Unlisted instruments have a longer threshold.
The applicable rates for debt instruments have changed several times, including significant amendments in recent Finance Acts affecting indexation and the treatment of different debt categories. Because of that churn, this article does not state a rate. Look up the current one for your assessment year, or ask an adviser.
Hold to maturity and there is no capital gains event. The face value is repaid, that repayment is not income, and you have simply been taxed on the interest along the way.
The two taxes side by side
| Interest | Sale before maturity | |
|---|---|---|
| Tax head | Income from Other Sources | Capital gains |
| Rate | Your slab rate | Depends on holding period and current law |
| When it applies | Every year, as interest accrues | Only in the year you sell |
| TDS | Yes, from FY 2023-24 | Not applicable |
| Hold to maturity? | Still taxed each year | No event at all |
Accrued interest on a purchase
Buy a bond between coupon dates and you pay the seller accrued interest on top of the price. That payment is a reimbursement of their earned interest, not your income, but the full coupon may later be reported to you gross. Keep the contract note showing the accrued component. It is the evidence for treating that portion as a return of capital rather than taxable interest. The accrued interest calculator shows the amount for a given bond.
Tax-free bonds
Between 2012 and 2016, several public sector entities issued tax-free bonds whose interest is exempt under section 10(15)(iv)(h). None have been issued since. They still trade on the secondary market, but because the exemption is valuable, they trade at prices that already reflect it. The yield you get buying one today sits well below its printed coupon. The exemption applies only to the interest. A capital gain on selling one is still taxable.
Capital gains bonds (54EC) are a different thing
"54EC bonds" from REC, PFC and IRFC let you defer tax on a long-term capital gain by reinvesting the gain into them within six months. They carry a low coupon and a five-year lock-in, and their purpose is deferral of a property or other asset gain, not income generation. Do not confuse them with ordinary corporate bonds. They solve a specific problem and make a poor choice for anything else.
The takeaway
Two taxes, kept separate:
- Interest: slab rate, every year, TDS now applies. This determines your real running return.
- Sale before maturity: capital gains rules, 12-month threshold for listed bonds, rate depends on the current law.
Hold to maturity and only the first one applies. For the post-tax return on a specific bond, the NCD returns calculator does the arithmetic.